"for their empirical research on cause and effect in the macroeconomy"

Cause and effect in the macroeconomy

How are GDP and inflation affected by a temporary
increase in the interest rate or a tax cut? What happens
if a central bank makes a permanent change
in its inflation target or a government modifies its
objective for budgetary balance? This year's Laureates
in economic sciences have developed methods
for answering these and many of other questions
regarding the causal relationship between economic
policy and different macroeconomic variables such
as GDP, inflation, employment and investments.

These occurrences are usually two-way relationships –
policy affects the economy, but the economy also affects
policy. Expectations regarding the future are primary
aspects of this interplay. The expectations of the private
sector regarding future economic activity and policy
influence decisions about wages, saving and investments.
Concurrently, economic-policy decisions are influenced
by expectations about developments in the private sector.
The Laureates' methods can be applied to identify these
causal relationships and explain the role of expectations.
This makes it possible to ascertain the effects of unexpected policy measures as well as systematic policy shifts.

Thomas Sargent has shown how structural macroeconometrics can be used to analyze permanent changes in economic
policy. This method can be applied to study macroeconomic
relationships when households and firms adjust their expectations
concurrently with economic developments. Sargent
has examined, for instance, the post-World War II era, when
many countries initially tended to implement a high-inflation
policy, but eventually introduced systematic changes in economic
policy and reverted to a lower inflation rate.

Christopher Sims has developed a method based on
so-called vector autoregression to analyze how the economy
is affected by temporary changes in economic
policy and other factors. Sims and other researchers have
applied this method to examine, for instance, the effects
of an increase in the interest rate set by a central bank.
It usually takes one or two years for the inflation rate to
decrease, whereas economic growth declines gradually
already in the short run and does not revert to its normal
development until after a couple of years.

Although Sargent and Sims carried out their research
independently, their contributions are complementary
in several ways. The laureates' seminal work during the
1970s and 1980s has been adopted by both researchers
and policymakers throughout the world. Today, the
methods developed by Sargent and Sims are essential
tools in macroeconomic analysis.

Thomas J. Sargent, U.S. citizen. Born 1943 in Pasadena, CA,
USA. Ph.D. 1968 from Harvard University, Cambridge, MA, USA.
William R. Berkley Professor of Economics and Business at
New York University, New York, NY, USA.
http://files.nyu.edu/ts43/public

The Royal Swedish Academy of Sciences, founded in 1739, is an independent organization
whose overall objective is to promote the sciences and strengthen their influence
in society. The Academy takes special responsibility for the natural sciences
and mathematics, but endeavours to promote the exchange of ideas between various disciplines.